Tenets of Investing #2 Focus on turnaround plays with high potential returns

This is the sixth part of my 10 part series on the tenets of my investment philosophy. I believe that investing without a game plan is equivalent to a baseball player swinging with his eyes closed. Sometimes contact will be made, but not having a game plan makes the at bat that much harder. I’ve set up a Tenets of Investing page where you can click to check out all 10 of my tenets. And just to screw with you guys, I’m going to write about them in a random order.

Most investors are pretty similar. They look for mature, blue chip companies, preferably ones that pay a dividend, look to buy them for a somewhat cheap price, and look to get about a 10% return per annum. These types of companies are perceived as safe, steady investments, investments that have stood up to the test of time.

I used to be one of those investors, with holdings like Telus, Reitmans and Investor’s Group still sitting in my portfolio. Some of my blue chip stocks made money, others have basically done nothing except paid the dividend. An investor can have success with this method, the caveat being that companies of such size are unlikely to beat the index by any significant amount, mostly because they make up most of the index.

When one spends time researching the investors that have blown away the index for a period of years, one style of investing is prominent- value investing. Buffett, Munger, Watsa, Taleb and Bruce Berkowitz- to name a few- have some of the best records over long periods of time, amassing those returns using some form of value investing. Even my boys over at Contra the Heard have crushed the market using a special kind of value investing, contrarian investing.

I choose to aim for high potential returns, rather than the 10-20% it seems like most investors strive for. I won’t even look at a stock if I don’t think it can go up a minimum of 50%, with my target price often set at 200-300% above my purchase. Just look at recent purchase Duoyon Printing, purchased on Friday at $2.80, with a sell target of $9.00. I choose to swing for the fences when I invest, rather than being content with singles and doubles.

It would be unrealistic for an investor to buy one of the blue chips I mentioned above with the expectation of a double or triple in the stock price. Most blue chips do not realistically have that potential. If you’re looking for the big returns, you have to look at the companies that are, for whatever reason, broken and beaten down.

There are many reasons why a company can enter into contrarian territory. Perhaps the whole sector is unloved- the U.S. housing sector and shipping stocks are two examples of that. Perhaps the company has taken on too much debt or has been losing money recently and the market isn’t bullish on their prospects. Sometimes contrarians will find a company that appears unloved for no tangible reason.

If a company has fallen 50-95% from it’s previous highs then it has the potential to go back to those highs, provided they fix whatever is keeping the company down. Like muscle in the human body, regaining muscle is much easier than gaining that muscle in the first place. Once the company starts to get on the right track, institutional investors start to recognize the company again, helping propel it even higher. Given enough time, a company can go from contrarian favorite to hot stock.

In 2003, Apple shares hit a low of just over $7 per share (split adjusted) before beginning their stratospheric rise to today’s levels. At that point PCs dominated the computer market, the ipod was in its infancy and the iphone or ipad hadn’t even been dreamed of. The company had spent the late 90s and early 2000s trading at 2-3 times the 2002-03 lows. Even Apple was once a contrarian stock.